Investment Analysis Chapter 4 Homeworks
Why would it be challenging to properly compare the performance of an equity fund to a fixed income mutual fund?
Equity funds and fixed-income funds contain different types of securities. Therefore, there are numerous differences that make comparison difficult. Equity funds invest primarily in the common stock of publically traded firms. Fixed-income funds invest in corporate bonds, Treasury bonds, mortgage-backed securities, or municipal (tax-free) bonds. The risks associated with stocks are primarily related to economic conditions and the success of the business operations. The risks associated with fixed-income securities are primarily interest rate risk and credit risk.
What are the advantages and disadvantages of exchange traded funds?
Exchange-traded funds can be traded during the day, just as the stocks they represent. They are most tax effective, in that they do not have as many distributions. They have much lower transaction costs. They also do not require load charges, management fees, and minimum investment amounts. The disadvantage is that ETFs must be purchased from brokers for a fee. Moreover, investors may incur a bid-ask spread when purchasing an ETF
What are the benefits to small investors of investing via mutual funds? What are the disadvantages?
Mutual funds offer many benefits. Some of those benefits include: the ability to invest with small amounts of money, diversification, professional management, low transaction costs, tax benefits, and the ability to reduce administrative functions. The costs associated with investing in mutual funds are generally operating expenses, marketing, distribution charges, and loads. Loads are fees paid when investors purchase or sell the shares.
Open-end equity mutual funds find it necessary to keep a small fraction of total investments, typically around 5% of the portfolio, in very liquid only market assets. Close-end funds do not have to maintain such a position in "cash-equivalent" securities. What difference between open-end and close-end funds might account for their differing policies?
Open-end funds must honor redemptions and receive deposits from investors. This flow of money necessitates retaining cash. Close-end funds no longer take and receive money from investors. As such, they are free to be fully invested at all times
You expect a tax-free municipal bond portfolio to provide a rate of return of 4%. Management fees of the fund are 0.6%. a. What fraction of the portfolio income is given up to fees? b. If the management fees for an equity fund are also 0.6%, but you expect a portfolio return of 12%, what fraction of portfolio income is given up to fees? c. Why might management fees be a bigger actor in your investment decision for bond funds than for stock funds? Can your conclusion help explain why unmanaged unit investment trusts tend to focus on the fixed-income market?
a. For the bond fund, the fraction of portfolio income given up to fees is: = 0.150 = 15.0% b. For the equity fund, the fraction of investment earnings given up to fees is: = 0.050 = 5.0% c. Fees are a much higher fraction of expected earnings for the bond fund, and therefore may be a more important factor in selecting the bond fund. FYI Only - This may help to explain why unmanaged unit investment trusts are concentrated in the fixed income market. The advantages of unit investment trusts are low turnover and low trading costs and management fees. This is a more important concern to bond-market investors.
